Pakistan shares win favor among value hunters

ChrisOliver

HONG KONG (MarketWatch) -- In spite of its woes, Pakistan is beginning to attract the attention of equity strategists who say investors have misjudged political risk, leaving the country's stock market a bargain compared to regional peers.

Pakistani stocks have the lowest valuation in the region, trading at a forward price-earnings ratio of 11.8, while the pace of earnings-per-share growth can hold its own against many better-known stories in Asia.

"Almost none of the clients that I speak to have invested in Pakistan," said Garry Evans, Asia-Pacific equity strategist with HSBC in Hong Kong. "It has gone up a lot but it is still the cheapest market in Asia."

Foreign investors have so far bypassed Pakistan in favor of other emerging markets where the political situation looks less dicey. That's little surprise given Pakistan's ongoing efforts to walk a delicate balancing act in the war against terrorism, while maintaining regional and domestic security.

It also faces the uphill battle in pulling off nationwide elections later this year, the second since President Pervez Musharraf came to power in a bloodless coup in 1999. The stakes where highlighted last month when commandos stormed Islamabad's Red Mosque after a week of sporadic gun battles with suspected Islamic militants, resulting in more than 180 deaths and marking one of the most violent day in the capital's recent history.

Analysts, however, caution against taking too dark a view.

HSBC's Evans described the political situation as "clearly a worry" after visiting Pakistan for the first time in early July as part of fact-finding mission to learn more about the nation's economy and stock market. He toured major cities for four days during the height of what became the mosque siege, a week of terrorist bombings and a 7% plunge in the Karachi 100 index.

While it wasn't the most auspicious time to be visiting, Evans said the mood on the streets was calmer than headlines were making out.

"It reminded me a bit of London in the 1980s when you were getting IRA bombs," he said. "Frankly the risk was very small and people kind of shrugged it off and had a fatalistic attitude to it.

"When you drive around the streets, it's absolutely business as normal, markets are full. People are really not worried about this."

Looking beyond the street battles, Evans said he was impressed by what was taking shape among company balance sheets and efforts by the government to reform the economy and privatize state enterprises.

"The fundamentals of the Pakistan equity market look fairly attractive," Evans wrote in a research note following the trip. "Once the political uncertainty has cleared, and our feeling is that it may by the end of the year, this is a market that Asia investors should have on their radar screens."

Evans said he was inspired to visit Pakistan after requests from clients for more information about the country.

Strong earnings growth

Earnings growth of the 14 companies in the MSCI Pakistan index have averaged 18% over the past five years and are expected to remain on an upbeat trend after dipping to 6% this year. Consensus estimates call for 15% earnings growth in 2008, and 14% in 2009, according to data-tracking firm IBES.

Pakistan's economy has also been on something of a tear. Gross domestic product growth has averaged 6.9% over the past five years and despite a cooling this year, analysts expect the economy to reaccelerate.

"Pakistan's economic expansion, initially bankrolled by a positive money supply shock, has transformed into a domestic consumption boom that is both bonafide and self sustaining," wrote Ahsan Javed Chishty, an analyst with BMA Capital in Karachi. In January, he forecast real economic growth of up to 6.8% in 2007, but says that estimate now looks too conservative.

Shares listed on the Karachi Stock Exchange have also been performing well. Since 2002, the MSCI Pakistan Index has risen by about 585%, trailing only Indonesia's 680% gain as the best performing market in Asia. The benchmark Karachi Stock Exchange index of 100 leading companies has risen 35.7% year-to-date, and is up 29% over the past 12 months, following a consolidation between August and December.

Strategists say the rally could have further to go with stock valuations underpinned by an attractive 5% yield. The Karachi Stock Exchange, the larger of the country's two bourses, has 657 listed companies and a combined market capitalization of $68 billion.

Undiscovered market

Foreigners, for the most part, have yet to discover the market. The average Asia ex-Japan mutual fund had only 0.1% of its assets in Pakistan as of May, equivalent to about $45 million, according to data by EPFR Global. Between July 2006 and April 2007 just $1.8 billion of foreign funds flowed into the equity market, according to estimates by The State Bank of Pakistan. More than $1 billion of that figure flowed into global depositary receipts of Pakistani companies.

In the last nine months, Oil & Gas Development (OGDC), United Bank (UBLS) and Muslim Commercial Bank listed global depository receipts. Most foreign net investment in the stock market so far has originated from expatriate Pakistanis and Gulf-region investors.

Other ways to access the Pakistani shares include U.S. over-the-counter listings for Pakistan Telecom
PKTLY, +0.00%
Pakistan International Airlines
PKSAF
Pakistan State Oil
PKSOF
and Pakistan Cement
CKWLY

"I think, personally, it's a better bet than India," says Andrew Clarke, a sales trader with Societe Generale in Hong Kong who trades Karachi among other Asian markets. "Volume from foreign investors has grown a lot this year in Pakistan, from hedge funds and traditional funds."

At just under 12 times forward price-earnings Karachi remains the least expensive in Asia, just below Thailand at 12.1, and cheaper than Indian stocks at 18.

Analysts caution risks other than politics could derail stock prices. The free float of the Karachi market is only about 25% to 40%, which means disposals of government-held stakes in nationalized enterprises could drive up the supply of shares and depress prices. The KSE 100 is also weighed disproportionately towards natural resource and financial companies, leaving it vulnerable to the fortunes of those sectors.

Another worry surrounds the potential for emerging markets to be hardest hit during a global equity shakeout.

"The timing at the moment to go in and buy Pakistan is probably not right if you are looking for immeditate profits," said Clarke.

"But if you are looking down the road and you don't mind taking a bit of pain and picking up some stocks and you are going to hold them for the long term; then, yes, start building your positions."

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